Jean Marc Cremer, EY Luxembourg Wealth and Asset Management Associate Partner EY Luxembourg

Jean Marc Cremer, EY Luxembourg Wealth and Asset Management Associate Partner EY Luxembourg

The EY quarterly market pulse regulatory update of June 21 is now available. It contains essential developments for the fund industry. In this series of articles, we reveal a selection of the market pulse. Today we focus on the CSSF FAQ on the use of securities financing transactions by UCITS.

In 2020, the CSSF conducted a thematic review of efficient portfolio management techniques used by undertakings for collective investment in transferable securities (“UCITS”) to assess compliance with regulatory provisions on revenues and costs/fees which are notably included in CSSF Circular 14/592, the CSSF circular which implemented ESMA Guidelines on ETF and other UCITS issues in Luxembourg law.

Primary change

In this context, the CSSF issued on 18 December 2020 Frequently Asked Questions (“FAQ”) to clarify certain requirements in terms of prospectus disclosures, revenues and costs/fees, conflicts of interest and best execution applicable to securities financing transactions (“SFTs”), including securities lending transactions, repurchase agreements (“repos”) and reverse repurchase agreements (“reverse repos”), buy-sell back and sell-buy back transactions, as well as total return swaps.

Disclosures should comply with the clarifications provided for in the FAQ by 30 September 2021 at the latest.

Key points

A. Prospectus Disclosures

1. General disclosures The prospectus of a UCITS which intends to use SFTs should, among other things, confirm whether SFTs will be used on a continuous or temporary basis and provide the expected and maximum proportion of the assets under management (“AUM”) that can be subject to SFTs.

2. Risk disclosures The prospectus should describe the risks linked to each individual SFT and to collateral management.

3. Costs/Fees disclosures The prospectus should also disclose the portion, after deduction of direct and indirect operational costs/fees, of gross revenues generated by the use of SFTs on the basis of arm’s length transactions, which is returned to the UCITS.

4. Conflicts of interest disclosures

Any material conflict of interest that may arise, notably from SFTs with related parties, should be appropriately disclosed in the prospectus.

B. SFT costs/fees

Only effective costs/fees corresponding to services rendered to the UCITS in the context of SFTs can be charged to the UCITS. Investment fund managers (“IFMs”) should perform a comprehensive assessment of the adequacy of the operational costs/fees deducted from gross revenues generated by SFTs. IFMs should notably document, with quantitative information, the relevance of the underlying cost drivers which make up the costs borne by the UCITS in order to demonstrate that these costs do not include any hidden revenues

C. Conflicts of interest and best execution

IFMs are expected to assess and document the operational model and the related processes underlying the SFT in order to identify and record potential conflicts of interest entailing a material risk of damage to the interests of a UCITS.

Where portfolio management has been delegated, robust initial and on-going due diligence and oversight should ensure that the best execution controls performed by the delegate are adequate.

Practical considerations

UCITS should undergo a review of their prospectus disclosures on SFTs, the related risks, costs and conflicts of interest to ensure that they comply with the FAQ.

Execution and accounting should be subject to robust controls and appropriate reporting and escalation to ensure that the interest of the UCITS is not undermined by undue hidden revenues or uncompetitive terms.

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